Mexico Monetary Policy November 2016

Mexico: Banxico raises interest rate following Trump win

November 17, 2016

In its first policy response to Donald Trump’s election victory, Mexico’s Central Bank (Banxico) announced its decision to increase the target of the monetary policy rate by 50 basis points to 5.25% at its 17 November policy meeting. Analysts had expected the Bank to take this action if the exchange rate of the peso against the U.S. dollar remained close to 20 MXN per USD in the wake of the U.S. elections results—as was the case. Economists had also seen that if the currency was trading at levels above 21 MXN per USD that would had warranted a stronger hike from Banxico. As the move was expected, the peso did not react strongly following the Bank’s announcement.

The Mexican monetary authority attributed its decision to increased volatility and the depreciation of the Mexican peso, derived mainly from the outcome of the U.S. elections. The Mexican peso was considered a barometer of investor sentiment during Trump’s campaign and in the aftermath of the election, the currency shed more than 17% in hectic trading sessions. In its statement, Banxico highlighted its concern that the balance of risks for both growth and inflation have deteriorated compared to its previous assessment in September. Despite an acceleration in economic activity in Q3—due to an improvement in exports and solid growth in household spending—the Bank pointed out that investment prospects remain weak and the new global developments pose substantial challenges to the Mexican economy. In terms of price developments, Banxico stated that although inflation remains contained near its target of 3.0%, it has trended upwards recently due to a continuing rise in the core component resulting from an FX pass-through. As a result, the Bank highlighted that a weaker currency is likely to put additional pressure on prices, deteriorating the balance of risks for inflation.

The latest hike brings the increase in interest rates this year to 200 basis points, after 50 basis-point moves in February, June and September when the MXN suffered from severe volatility. Alexis Milo, Chief Mexico Economist, and Alejandro Martínez-Cruz, Head of Latam Fixed Income Strategy at HSBC see the Bank’s latest hike as a positive measure to contain inflation and consider further rate hikes likely going forward:

“It is clear for us that this hike was mainly driven by the effects stemming from the US election outcome, as a weaker Mexican peso may result in a higher and faster pass-through effect on inflation. In this regard, we take today's hike as a prudent measure to support the MXN and consequently help to contain inflation going forward. At the same time, the relative stability of the MXN over the week prior to today's announcement allowed Banxico to increase the monetary policy rate by 50bp, saving some bullets for the future. Our view is that the next move from Banxico will come in tandem with the Federal Reserve, which is likely to happen in December this year according to market expectations. However, our monetary policy call remains highly dependent on the exchange rate, and if additional bouts of volatility occur, then the likelihood for additional rate hikes will strengthen. All in all, today's announcement suggests that Banxico will take a defensive stance in the coming months in case developments on Trump's intended policies have an adverse impact on the Mexican peso.”

Looking forward, Banxico remains ready to “continue taking necessary measures to consolidate the efficient convergence of inflation to the 3 per cent objective, with full flexibility, whenever and to whatever extent conditions should require”. The Bank’s next monetary policy meeting is scheduled for 15 December, just after the Fed’s 13–14 December policy meeting. In a recent Congress hearing, Chair Janet Yellen stated that that a rise in short-term US interest rates could “become appropriate relatively soon”, rising expectations of a hike in December north of the border. In this regard, Edward Glossop, Emerging Market Economist at Capital Economics, commented:

“It’s clear that further [Mexican] hikes are on the cards. We expect another half-point increase at December’s meeting, taking the policy rate to 5.75 per cent by year-end, and further hikes next year too.”

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